Competition Based Pricing

Competition-Based Pricing Definition

Competition-based pricing is a simple way to set the price of a product by looking at what similar products from competitors cost. Businesses choose a price that's either lower, equal, or slightly higher than their competitors to attract customers. Competition-based pricing is standard for companies that produce goods and services that do not have strong brand loyalty and many available substitutes.

Competition-Based Pricing Method

Utilizing the competition-based pricing method involves setting prices by considering factors such as rival strategies, costs, and market offerings. Customers often determine a product's value by comparing prices other businesses charge for similar items.

To effectively assess competitors' pricing strategies, a company must ask several key questions:

1. How does the company's market offering compare to competitors in terms of value provided to customers?

   • If customers perceive the company's product as more valuable, it may warrant a higher price.
   • If the product is seen as less valuable, the company can either reduce the price or work to change customer perceptions to justify a higher cost.

2. Is the company facing numerous competitors with high prices relative to the value they offer? If yes, the company can adopt lower pricing to force less capable competitors out of the market.

3. Is the market is dominated by larger competitors with lower prices? If yes, the company can target underserved market niches by offering value-added products and services at higher costs.

By mastering the competition-based pricing method, businesses can effectively position themselves within the market and attract customers seeking the best value for their money.

Competition-based pricing is only successful if the firm can compete with its rivals on production costs.

Competition-Based Pricing Example

An example of competition-based pricing includes analyzing competitors' prices and then setting a similar but slightly lower price for one's products. Sellers do this by keeping track of rivals' prices through market research. Research can also include tracking price changes over time to analyze trends, such as the costs of certain goods rising or falling based on seasons. Let's take a look at the two most famous examples of competition-based pricing.

Coca-Cola vs. Pepsi

Disadvantages of Competition-Based Pricing

Competition-based pricing comes with disadvantages. Competition-based pricing can be complicated if there are few substitute goods upon which price comparisons can be made. This will put new entrants at a disadvantage, as they may not know where to set a competitive price. A mistake in pricing made upon market entry can quickly hurt a company, as potential customers hold firm to first impressions. Even quick changes in "incorrect" prices may not be sufficient to save a product. Let's take a look at the most important disadvantages of the competition-based pricing

Price wars

Competition-based pricing can lead to price wars, where companies continuously lower their prices to outdo each other, which can result in reduced profits. For example, the airline industry has experienced price wars, leading to lower ticket prices, but also diminished profitability for some carriers.

Because rivals are losing customers, they also have little choice but to reduce their costs. This can result in the initial price-cutter reducing its prices even further, hoping to continue luring away customers from rivals. The process can continue in a perpetual downward slide in prices. While this may seem great for consumers enjoying regular discounts, it can harm the market overall if it ends up driving some firms out of business.

Price wars that drive firms out of business can raise average prices in the long run due to reduced competition. Price wars are usually pursued by the dominant firm in a market with the lowest production costs due to its larger size and better economies of scale. Once it has driven its smaller rivals out of the market, the dominant firm can raise its prices above where they were when the price war began. This action is often known as predatory pricing and is illegal.

Collusion risk

In some cases, competitors may engage in illegal collusion, secretly agreeing to set prices at a certain level to avoid competition. This can lead to artificially high prices, harming consumers and potentially leading to legal consequences for the colluding companies.

Fortunately, collusion is less common than is often expected, as firms are incentivised to cheat on the collusion deal. If five large firms collude to set a higher price on a similar product, the first firm to break the agreement and charge a lower fee will win over most customers in the market. This can trigger a price war that harms all firms' profitability. Thus, firms tend to be reluctant to collude on price.

Neglecting non-price factors

Competition-based pricing can cause businesses to focus too much on price and overlook other important factors, such as product quality, customer service, and brand reputation. For instance, a company might lower its prices to compete with a low-cost competitor but inadvertently harm its brand image by compromising on product quality.

Ignoring cost structure

Basing prices solely on competitors' pricing may lead businesses to ignore their own cost structure, resulting in unsustainable pricing strategies. For example, if a company has higher production costs than its competitor but still tries to match its prices, it may struggle to maintain profitability.

Advantages of Competition-Based Pricing

There are several important benefits of using competition-based pricing. Let's take a look!

Attracting price-sensitive customers

By offering competitive prices, businesses can attract price-conscious customers, increasing sales volume. For example, Walmart's "Everyday Low Price" strategy attracts customers looking for the best deals on everyday items.

Simplified pricing decisions

Basing prices on competitors' pricing allows businesses to focus on the market and reduce the complexity of pricing decisions. For instance, a small retail store may set its prices by monitoring the prices of similar items at nearby big-box stores.

Adaptability

Competition-based pricing helps businesses stay agile and adapt to market changes quickly. For example, if a competitor lowers their price, a company can respond promptly by adjusting their own prices to maintain competitiveness.

Consumer benefits

Lower prices resulting from competition-based pricing enable consumers to afford more necessary goods, such as groceries, gasoline, and other high-demand items. This approach caters to price-sensitive customers and helps increase the accessibility of essential products.

Reducing market entry risk

Competition-based pricing helps new businesses gauge the prices that customers are willing to pay, reducing the risk associated with market entry and expansion. By understanding competitors' accepted prices, new firms can strategically position themselves for success in the market.